"The Worst ETFs You Can Own"

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Taylor Larimore
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"The Worst ETFs You Can Own"

Postby Taylor Larimore » Mon Jul 17, 2017 9:19 am

Bogleheads:

Ben Carlson has written this article about what can happen when investors try to "beat the market":

The Worst ETFs You Can Own

Best wishes.
Taylor
Last edited by Taylor Larimore on Mon Jul 17, 2017 11:43 am, edited 1 time in total.
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Re: "The Worst ETFs You Can Own"

Postby nisiprius » Mon Jul 17, 2017 10:23 am

See also Inverse and leveraged ETFs which includes an illustration of how a 2X leveraged ETF not only failed to earn double the returns of a plain S&P 500 fund, it actually earned less than the unleveraged fund.
Image

I believe the Carlson should have made a point of quoting some of the actual language straight from the UPRO prospectus:
Proshares wrote:For periods longer than a single day, the Fund will lose money when the level of the Index is flat, and it is possible that the Fund will lose money even if the level of the Index rises.
My boldfacing:
the Fund may not be suitable for all investors andshould be used only by knowledgeable investors who
understand the potential consequences of seeking daily leveraged investment results. Shareholders should actively manage andmonitor their investments, as frequently as daily.... The Fund does not seek to achieve its stated investment objective over a period of time greater than a single day.
It is weasel-worded, but the clear message is: do not use leveraged ETFs as part of any buy-and-hold strategy.

One of Proshares' competitors, makes this explicit. They list their ETFs in a table, with the unleveraged ETFs under the heading "long-term investment" and the leveraged ETFs under the heading "short-term trading."

These funds are for people who think they can predict daily market fluctuations, day by day, and wish to make short-term bets. For example, if you were convinced that the next Fed announcement was going to be different from what the market was expecting, and wanted to bet on that.
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Re: "The Worst ETFs You Can Own"

Postby saltycaper » Mon Jul 17, 2017 10:36 am

In other news, the worst utensils you can own are knives and forks.*

*Provided I assume but do not state that you eat only soup.
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Re: "The Worst ETFs You Can Own"

Postby aegis965 » Mon Jul 17, 2017 11:21 am

Taylor Larimore wrote:Bogleheads:

Ben Carlson has written this article about what can happen when investors try to "beat the market":

The Worst ETFs You Can Own

Best wishes.
Taylor


Is the link wrong?

saltycaper wrote:In other news, the worst utensils you can own are knives and forks.*

*Provided I assume but do not state that you eat only soup.


EVERYONE SHOULD EAT NOTHING BUT SOUP!!!
I came, I saw, I purchased at a low multiple.

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 11:24 am

I would not buy a leveraged ETF. What I recommend are ETFs based on indexes.
A fool and his money are good for business.

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Re: "The Worst ETFs You Can Own"

Postby BogleAlltheWay » Mon Jul 17, 2017 11:46 am

nisiprius wrote:See also Inverse and leveraged ETFs which includes an illustration of how a 2X leveraged ETF not only failed to earn double the returns of a plain S&P 500 fund, it actually earned less than the unleveraged fund.
Image


Looking at the chart, it appears would be ahead if you had purchased it anytime between late 2008 and 2010. What is the downside of switching to a leveraged ETF after a market crash?

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Re: "The Worst ETFs You Can Own"

Postby Taylor Larimore » Mon Jul 17, 2017 11:52 am

aegis965 wrote:Is the link wrong?


Yes, the link was wrong. Although the message is the same (it's very hard to beat the market).

I've edited my opening post to change the link.

Thank you and best wishes
Taylor
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Re: "The Worst ETFs You Can Own"

Postby triceratop » Mon Jul 17, 2017 11:56 am

nedsaid wrote:I would not buy a leveraged ETF. What I recommend are ETFs based on indexes.


What about an unleveraged ETF based on the "2X US Stock Market index"? :wink:

This is just to make the point that there are so many niche indices around right now that we should be clear that it isn't merely the concept of an index we like, but something additional to that: broad, diversified, indices with low turnover enabling largely passive management.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 12:04 pm

triceratop wrote:
nedsaid wrote:I would not buy a leveraged ETF. What I recommend are ETFs based on indexes.


What about an unleveraged ETF based on the "2X US Stock Market index"? :wink:

This is just to make the point that there are so many niche indices around right now that we should be clear that it isn't merely the concept of an index we like, but something additional to that: broad, diversified, indices with low turnover enabling largely passive management.


Well, let me more specific with actual ETFs that I own. US Total Bond Market Index, Small Cap Value Index, S&P 600 Small Cap Index ETF, Micro-Cap Index ETF, REIT Index ETF, International Small-Cap Index ETF.

You will notice that for the most part, I am using these for greater Small-Cap exposure. Also trying to factor tilt.
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Re: "The Worst ETFs You Can Own"

Postby Taylor Larimore » Mon Jul 17, 2017 12:16 pm

Well, let me more specific with actual ETFs that I own. US Total Bond Market Index, Small Cap Value Index, S&P 600 Small Cap Index ETF, Micro-Cap Index ETF, REIT Index ETF, International Small-Cap Index ETF

Nedsaid:

Do you realize that you do not own stocks in any of the largest and most successful companies in the world.

Best wishes
Taylor
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Re: "The Worst ETFs You Can Own"

Postby triceratop » Mon Jul 17, 2017 12:23 pm

nedsaid wrote:
triceratop wrote:
nedsaid wrote:I would not buy a leveraged ETF. What I recommend are ETFs based on indexes.


What about an unleveraged ETF based on the "2X US Stock Market index"? :wink:

This is just to make the point that there are so many niche indices around right now that we should be clear that it isn't merely the concept of an index we like, but something additional to that: broad, diversified, indices with low turnover enabling largely passive management.


Well, let me more specific with actual ETFs that I own. US Total Bond Market Index, Small Cap Value Index, S&P 600 Small Cap Index ETF, Micro-Cap Index ETF, REIT Index ETF, International Small-Cap Index ETF.

You will notice that for the most part, I am using these for greater Small-Cap exposure. Also trying to factor tilt.


Yeah yeah I know, I'm teasing you a bit. I use some of those ETFs myself for similar reasons.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 12:29 pm

Taylor Larimore wrote:
Well, let me more specific with actual ETFs that I own. US Total Bond Market Index, Small Cap Value Index, S&P 600 Small Cap Index ETF, Micro-Cap Index ETF, REIT Index ETF, International Small-Cap Index ETF

Nedsaid:

Do you realize that you do not own stocks in any of the largest and most successful companies in the world.

Best wishes
Taylor


Hi Taylor:

I do own lots of other investments. The US Total Stock Market Index is actually my largest investment and I have plenty of the large mega-caps. These ETFs were purchased primarily to tilt my portfolio a bit towards the smaller stocks. For example, my insurance company did a portfolio review for me and they said that I had very little small-cap representation at the time. So I purchased the S&P 600 Small Cap Index ETF to remedy that problem. The Small Cap Value Index, the Micro-Cap Index ETF, the REIT Index ETF, and the International Small-Cap Index ETF were purchased in 2007-2008 on the recommendation of the Merriman organization as I sought to Small/Value tilt my portfolio.

Here is my Morningstar stock stylebox:

26 22 17
05 07 06
07 06 04

So I have tilted but not excessively so. Be reassured that I am not way out there in left field.

Thanks for your comments.
A fool and his money are good for business.

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 12:30 pm

Triceratop and Taylor Larimore:

My bark is worse than my bite.

Best wishes,

Ned
A fool and his money are good for business.

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Re: "The Worst ETFs You Can Own"

Postby Dottie57 » Mon Jul 17, 2017 12:44 pm

aegis965 wrote:
Taylor Larimore wrote:Bogleheads:

Ben Carlson has written this article about what can happen when investors try to "beat the market":

The Worst ETFs You Can Own

Best wishes.
Taylor


Is the link wrong?

saltycaper wrote:In other news, the worst utensils you can own are knives and forks.*

*Provided I assume but do not state that you eat only soup.


EVERYONE SHOULD EAT NOTHING BUT SOUP!!!


Too hot for soup!

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Re: "The Worst ETFs You Can Own"

Postby Taylor Larimore » Mon Jul 17, 2017 12:47 pm

Nedsaid:

I am glad that you own more stock funds than you listed.

Would you mind listing all your funds? I'm curious.

Thank you and best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: "The Worst ETFs You Can Own"

Postby Thesaints » Mon Jul 17, 2017 12:49 pm

Leveraged ETF's are best used for temporarily hedging other positions. Using them for an extended time is simply wrong. They will not replicated the index times the leverage factor. It is simple math once one understands the reference index value resets daily.

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 12:55 pm

Taylor Larimore wrote:Nedsaid:

I am glad that you own more stock funds than you listed.

Would you mind listing all your funds? I'm curious.

Thank you and best wishes.
Taylor


I started a New 'Doo thread were I go into detail what I own and my actual performance results. As far as I know, I am the only Boglehead who has posted his actual results. Typing "My New Doo" in the search box will bring it up. It will tell you more than you would ever want to know.

Best wishes,

Ned
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Re: "The Worst ETFs You Can Own"

Postby triceratop » Mon Jul 17, 2017 12:57 pm

nedsaid (and Taylor),
Since we're on the discussion of what ETFs to own and not own, here are my entire holdings, ranked by account value:

VTI - Vanguard Total Stock Market
IXUS - iShares Core MSCI Total International Stock Market
VBR - Vanguard Small Cap Value Index
VSS - Vanguard FTSE All World ex US Small Cap
VWO - Vanguard FTSE Emerging Markets
VGIT - Vanguard Intermediate-Term Govt Bond
FNDE - Schwab Fundamental Emerging Markets Large

It's quite simple to me, because I own only 2 US stock funds, and only 4-5 foreign stock funds (where the precise tilts and exposures are more difficult to construct with few funds). I use a spreadsheet to distribute new contributions.

And, before anyone points out costs or taxes: my weighted portfolio tax efficiency is about 0.13% with a weighted expense ratio of 0.09-0.11%.

As far as I know, I am the only Boglehead who has posted his actual result


Robert T has done this, with attribution analysis due to the factor exposures he targets.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: "The Worst ETFs You Can Own"

Postby nedsaid » Mon Jul 17, 2017 1:16 pm

Okay, Triceratop, there are two of us who have posted our investment results. I will say that actually calculating my returns was eye opening. I outperformed the "Lazy Portfolios" and felt great about that.

Then I compared that to 50% US Total Stock Market Index, 17% Total International Stock Index, and 33% US Total Bond Market Index with the percentages held steady roughly reflecting my actual asset allocation over time. I lost to the Three Fund Portfolio, pretty much because Value hasn't done so well since the 2008-2009 financial crisis.

I also calculated the returns of my individual stocks. Over 15 years, I matched the returns of a Value fund that I owned and admired for many years. Not bad. Trouble was, I trailed the Total Stock Market Index, The S&P 500, and even the Vanguard Value Index. Over 1, 3, and 5 year returns, my stocks have beaten the benchmarks and I could crow over that. Problem is, long term is what counts.

So pretty much, you live by the tilts and you die by the tilts. Since the 2007-2008 financial crisis, my returns have suffered because of the tilting. If I had calculated all of this just before the 2008-2009 financial crisis, my investment results would have been much better. I would have been the man! A financial planner really liked what I had done with my portfolio pre-financial crisis.
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Re: "The Worst ETFs You Can Own"

Postby Taylor Larimore » Mon Jul 17, 2017 1:58 pm

nedsaid and Triceratop:

Thank you for sharing.

If you haven't done so, you might want to read my Simplicity link below.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: "The Worst ETFs You Can Own"

Postby Swelfie » Mon Jul 17, 2017 5:29 pm

There was a great discussion buried in a long thread here a while back discussing buy and hold leveraged ETFs. Basically it pointed out that the problem with them was that they amplified market swings by relevering/delevering daily in the opposite direction of rebalancing, affectively buying high, selling low in a crash and buying low, selling high in a rise. The more rapid the swing, the stronger the amplification.

But putting tight rebalancing bands and fervently rebalancing, the tracking error could be mostly eliminated, at the cost of higher trading cost.

The argument was made that these might be useful for tightly constrained tax advantaged space. One person was indeed doing this and shared data from their own portfolio with impressively little tracking error. But they also said they were rebalancing every few days during high volatility, so not a set it and forget it strategy. The data was pretty convincing though.

Personally, I'd just use futures to do this, but that may not be an option for many in their tax advantaged accounts.

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Re: "The Worst ETFs You Can Own"

Postby Thesaints » Mon Jul 17, 2017 5:46 pm

One can get leverage factors around 2 with DITM options, especially now with VIX on the lower side...
The risk is being assigned in case there are large dividends involved. Other than that, it is certainly superior than using leveraged ETF's.

Not sure how "rebalancing" (with what, btw ?) can help cure the leveraged ETF's original sin. As you point out the problem is that they are leveraged for swings relative to the daily level. After some time, the drift in price spoils the leverage factor for the ETF one aquired earlier.
Last edited by Thesaints on Mon Jul 17, 2017 5:55 pm, edited 2 times in total.

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Re: "The Worst ETFs You Can Own"

Postby indexonlyplease » Mon Jul 17, 2017 5:46 pm

triceratop wrote:nedsaid (and Taylor),
Since we're on the discussion of what ETFs to own and not own, here are my entire holdings, ranked by account value:

VTI - Vanguard Total Stock Market
IXUS - iShares Core MSCI Total International Stock Market
VBR - Vanguard Small Cap Value Index
VSS - Vanguard FTSE All World ex US Small Cap
VWO - Vanguard FTSE Emerging Markets
VGIT - Vanguard Intermediate-Term Govt Bond
FNDE - Schwab Fundamental Emerging Markets Large

It's quite simple to me, because I own only 2 US stock funds, and only 4-5 foreign stock funds (where the precise tilts and exposures are more difficult to construct with few funds). I use a spreadsheet to distribute new contributions.

And, before anyone points out costs or taxes: my weighted portfolio tax efficiency is about 0.13% with a weighted expense ratio of 0.09-0.11%.

As far as I know, I am the only Boglehead who has posted his actual result


Robert T has done this, with attribution analysis due to the factor exposures he targets.


Is this a portfolio you follow from one of the gurus that made it up or is this something you put together?? Just wondering.

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Re: "The Worst ETFs You Can Own"

Postby whodidntante » Mon Jul 17, 2017 5:51 pm

The leveraged ETFs that are not designed for buy and hold should not be bought and held. Who knew? Anyone with reading comprehension, that's who.

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Re: "The Worst ETFs You Can Own"

Postby indexonlyplease » Mon Jul 17, 2017 5:51 pm

nedsaid wrote:
Taylor Larimore wrote:
Well, let me more specific with actual ETFs that I own. US Total Bond Market Index, Small Cap Value Index, S&P 600 Small Cap Index ETF, Micro-Cap Index ETF, REIT Index ETF, International Small-Cap Index ETF

Nedsaid:

Do you realize that you do not own stocks in any of the largest and most successful companies in the world.

Best wishes
Taylor


Hi Taylor:

I do own lots of other investments. The US Total Stock Market Index is actually my largest investment and I have plenty of the large mega-caps. These ETFs were purchased primarily to tilt my portfolio a bit towards the smaller stocks. For example, my insurance company did a portfolio review for me and they said that I had very little small-cap representation at the time. So I purchased the S&P 600 Small Cap Index ETF to remedy that problem. The Small Cap Value Index, the Micro-Cap Index ETF, the REIT Index ETF, and the International Small-Cap Index ETF were purchased in 2007-2008 on the recommendation of the Merriman organization as I sought to Small/Value tilt my portfolio.

Here is my Morningstar stock stylebox:

26 22 17
05 07 06
07 06 04

So I have tilted but not excessively so. Be reassured that I am not way out there in left field.

Thanks for your comments.


Thats interesting about the Paul Merriman recommended tilt. I found great interest in his ideas about adding it to my son's target dated fund and possibly my 3 fund. But in the end it was to much work and stress for the unknown. Nice to see you are honest about your portfolio. That's almost 10 years of small value tilt. But who knows maybe the next 10 might be better.

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Re: "The Worst ETFs You Can Own"

Postby triceratop » Mon Jul 17, 2017 6:08 pm

indexonlyplease wrote:
triceratop wrote:nedsaid (and Taylor),
Since we're on the discussion of what ETFs to own and not own, here are my entire holdings, ranked by account value:

VTI - Vanguard Total Stock Market
IXUS - iShares Core MSCI Total International Stock Market
VBR - Vanguard Small Cap Value Index
VSS - Vanguard FTSE All World ex US Small Cap
VWO - Vanguard FTSE Emerging Markets
VGIT - Vanguard Intermediate-Term Govt Bond
FNDE - Schwab Fundamental Emerging Markets Large

It's quite simple to me, because I own only 2 US stock funds, and only 4-5 foreign stock funds (where the precise tilts and exposures are more difficult to construct with few funds). I use a spreadsheet to distribute new contributions.

And, before anyone points out costs or taxes: my weighted portfolio tax efficiency is about 0.13% with a weighted expense ratio of 0.09-0.11%.

As far as I know, I am the only Boglehead who has posted his actual result


Robert T has done this, with attribution analysis due to the factor exposures he targets.


Is this a portfolio you follow from one of the gurus that made it up or is this something you put together?? Just wondering.


I never understood the adherence to guru portfolios by some people. It especially irks me when people cite a particular guru and use that as the reason for/against a given portfolio choice (ahem...International & Jack Bogle). So no, this was not advocated by any particular guru.

The goal aligns with recommendations by Larry Swedroe for targeting Size/Value in a globally-diversified portfolio. I have no idea where I will live most of my life, nor where I will retire. Currency risk doesn't really bother me at this stage in the accumulation process; I see it as currency diversification.

Currently I'm not as much tilted to Size/Value internationally as I would prefer due to existing investments internationally before I had commission-free access to ideal funds (FNDC/FNDE).

It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this. However, the three fund portfolio is quite possibly the best guru portfolio I could imagine, because it is itself a rejection of guru portfolios.
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Re: "The Worst ETFs You Can Own"

Postby Swelfie » Mon Jul 17, 2017 8:17 pm

Thesaints wrote:Not sure how "rebalancing" (with what, btw ?) can help cure the leveraged ETF's original sin. As you point out the problem is that they are leveraged for swings relative to the daily level. After some time, the drift in price spoils the leverage factor for the ETF one aquired earlier.


Imagine 50/50 portfolio made of SSO (2x leveraged S&P500) and TBM. In Monetary expenditure you are 25/75, but in notional you are 50/50.

Stock drop 5%. That's a 10% drop to you, making it 45/55 notional. The ETF is now over leveraged, so they sell into the dip and reduce holdings by another 1.25% (if I'm getting my math right) which is the source of the tracking error. This puts you at about 44.4/55.6. If you immediately sell 5.6% of your bonds and buy more SSO, you will have undone their daily adjustment by buying not only the value of the stock lost to the market movement, but you have additionally bought the extra 1.25% of equities, reversing their trade.

Since it tracks pretty closely in low volatility, it's not much of an issue. But when volatility increases the tracking error compounds rapidly, causing you to need to rebalance frequently to keep your holdings in notional value within your AA.

That's my off the cuff, typing from my phone, not thinking about it too hard understanding of the argument.

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Re: "The Worst ETFs You Can Own"

Postby Thesaints » Mon Jul 17, 2017 8:27 pm

Thank you.
So, it could come to continuously trade in and out the leveraged ETF (limited to the differential with desired AA) ?
Assuming costs can be ignored, there is the disadvantage of transforming all CG in excess of bonds return into short-term CG, or am I missing something ?

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Re: "The Worst ETFs You Can Own"

Postby Swelfie » Mon Jul 17, 2017 9:10 pm

Thesaints wrote:Thank you.
So, it could come to continuously trade in and out the leveraged ETF (limited to the differential with desired AA) ?
Assuming costs can be ignored, there is the disadvantage of transforming all CG in excess of bonds return into short-term CG, or am I missing something ?


Sounds about right. And oh, I imagine this would be horrible in taxable with the CG its likely to throw off.

Here is a PDF describing a method that closely tracks, but as I recall, simply keeping tight rebalancing bands was "close enough."

http://www.math.nyu.edu/faculty/avellan ... _Zhang.pdf

And here is the heart of the thread I remembered:

viewtopic.php?f=10&t=143037&p=2217409&hilit=Sso#p2217409

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Re: "The Worst ETFs You Can Own"

Postby iceport » Tue Jul 18, 2017 2:29 am

triceratop wrote:It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this.

Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)
"Discipline matters more than allocation.” ─William Bernstein

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Re: "The Worst ETFs You Can Own"

Postby triceratop » Tue Jul 18, 2017 2:50 am

iceport wrote:
triceratop wrote:It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this.

Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)


I disagree with your presumption.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: "The Worst ETFs You Can Own"

Postby iceport » Tue Jul 18, 2017 3:47 am

triceratop wrote:
iceport wrote:
triceratop wrote:It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this.

Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)


I disagree with your presumption.

Okay, but that doesn't really answer the question. If an investor lacks even the ability to select an appropriate strategy carefully designed by a guru, then why would that investor fare any better in concocting their own?
"Discipline matters more than allocation.” ─William Bernstein

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Re: "The Worst ETFs You Can Own"

Postby nisiprius » Tue Jul 18, 2017 7:14 am

Swelfie wrote:There was a great discussion buried in a long thread here a while back discussing buy and hold leveraged ETFs. Basically it pointed out that the problem with them was that they amplified market swings by relevering/delevering daily in the opposite direction of rebalancing, affectively buying high, selling low in a crash and buying low, selling high in a rise. The more rapid the swing, the stronger the amplification.

But putting tight rebalancing bands and fervently rebalancing, the tracking error could be mostly eliminated, at the cost of higher trading cost.

The argument was made that these might be useful for tightly constrained tax advantaged space. One person was indeed doing this and shared data from their own portfolio with impressively little tracking error. But they also said they were rebalancing every few days during high volatility, so not a set it and forget it strategy. The data was pretty convincing though.

Personally, I'd just use futures to do this, but that may not be an option for many in their tax advantaged accounts.
I don't want exhume it all now, but I think "the argument was made" by an executive at one of the firms that offers leveraged ETFs.
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Re: "The Worst ETFs You Can Own"

Postby triceratop » Tue Jul 18, 2017 9:57 am

iceport wrote:
triceratop wrote:
iceport wrote:
triceratop wrote:It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this.

Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)


I disagree with your presumption.

Okay, but that doesn't really answer the question. If an investor lacks even the ability to select an appropriate strategy carefully designed by a guru, then why would that investor fare any better in concocting their own?


Implicit in following a portfolio from a guru is that you are relying on their expertise to cover for a lack of knowledge in a specific area. I'm not saying I do not believe in reading articles and books by gurus: indeed I like Bernstein, Bogle, Thau, and Swedroe. However since your guru is covering a lack of knowledge, how does that appeal to authority result in a conviction to stay the course through hard times? It's better to know why you are making every decision/trade off in a portfolio, when it comes to having the fortitude to stay the course.
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Re: "The Worst ETFs You Can Own"

Postby Tamalak » Tue Jul 18, 2017 1:20 pm

"It is weasel-worded, but the clear message is: do not use leveraged ETFs as part of any buy-and-hold strategy."

Are we absolutely sure about this?

If we tracked a 2x total stock ETF over 100 years, would that still be worse than a 1x total stock? I'm guessing yes.

But what about a 1.1x? A 1.5?

I don't remember where but I believe I read that, depending on what period you're looking at, the highest historical return is at 1.5x or so leverage.

Obviously, the risk is much higher, and most likely the Sharpe ratio is worse. I'm not doing it personally. But I'm tempted.

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Re: "The Worst ETFs You Can Own"

Postby iceport » Tue Jul 18, 2017 1:22 pm

triceratop wrote:
iceport wrote:
triceratop wrote:
iceport wrote:
triceratop wrote:It makes much more sense in my estimation to find a portfolio strategy one can stick with for the long term; guru portfolios don't align well with this.

Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)


I disagree with your presumption.

Okay, but that doesn't really answer the question. If an investor lacks even the ability to select an appropriate strategy carefully designed by a guru, then why would that investor fare any better in concocting their own?


Implicit in following a portfolio from a guru is that you are relying on their expertise to cover for a lack of knowledge in a specific area. I'm not saying I do not believe in reading articles and books by gurus: indeed I like Bernstein, Bogle, Thau, and Swedroe. However since your guru is covering a lack of knowledge, how does that appeal to authority result in a conviction to stay the course through hard times? It's better to know why you are making every decision/trade off in a portfolio, when it comes to having the fortitude to stay the course.

I agree completely. But that seems more an argument for continued learning about investing than against following the advice of a guru. I would argue that, for any given level of knowledge, the use of a strategy endorsed by a guru can provide reassurance to stay the course. It has for me, even as my knowledge of investing has expanded immensely since adopting the basic outline of my AA roughly 15 years ago.

Though perhaps I should be comforted by my propensity for self-doubt, through both good and bad market conditions the fact that my portfolio strongly resembles several widely recognized authorities on investing gave me added encouragement and peace of mind to stay the course. By definition, any guru knows far more than I do. So if my portfolio conforms to the basic outline of several gurus I've come to respect and trust, I know I'm not making any huge mistakes. And that, ultimately, is the greatest challenge in investing: avoiding significant mistakes, rather than striving for some elusive "optimum" strategy.
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Re: "The Worst ETFs You Can Own"

Postby triceratop » Tue Jul 18, 2017 1:57 pm

iceport wrote:
triceratop wrote:
iceport wrote:
triceratop wrote:
iceport wrote:Why would it be any harder to stay the course over the long term with a strategy advocated by a guru than with one dreamed up by an individual investor? (Presumably, an investor would not choose to adopt a guru strategy if it didn't align well with their circumstances, preferences and knowledge.)


I disagree with your presumption.

Okay, but that doesn't really answer the question. If an investor lacks even the ability to select an appropriate strategy carefully designed by a guru, then why would that investor fare any better in concocting their own?


Implicit in following a portfolio from a guru is that you are relying on their expertise to cover for a lack of knowledge in a specific area. I'm not saying I do not believe in reading articles and books by gurus: indeed I like Bernstein, Bogle, Thau, and Swedroe. However since your guru is covering a lack of knowledge, how does that appeal to authority result in a conviction to stay the course through hard times? It's better to know why you are making every decision/trade off in a portfolio, when it comes to having the fortitude to stay the course.

I agree completely. But that seems more an argument for continued learning about investing than against following the advice of a guru. I would argue that, for any given level of knowledge, the use of a strategy endorsed by a guru can provide reassurance to stay the course. It has for me, even as my knowledge of investing has expanded immensely since adopting the basic outline of my AA roughly 15 years ago.

Though perhaps I should be comforted by my propensity for self-doubt, through both good and bad market conditions the fact that my portfolio strongly resembles several widely recognized authorities on investing gave me added encouragement and peace of mind to stay the course. By definition, any guru knows far more than I do. So if my portfolio conforms to the basic outline of several gurus I've come to respect and trust, I know I'm not making any huge mistakes. And that, ultimately, is the greatest challenge in investing: avoiding significant mistakes, rather than striving for some elusive "optimum" strategy.


Fair enough; I think we basically agree. My bias is to view people following a guru portfolio as no longer learning more. That may not be entirely correct. I am troubled by a great deal of confirmation bias I see here with regards to international investing, with Bogleheads who follow a "guru" like John Bogle. Logically, the natural place to start is global market cap weight, with possible reductions for currency effects and tax inefficiencies at investor discretion (which seems fine to me!). But I see a number of people blindly follow what Jack Bogle says. What if International outperforms the US for the next 30 years? It's highly plausible. Jack Bogle is unlikely to be around in 30 years. What about the next gurus who will say "this time is different", encouraging such investors to diversify internationally (given recent outperformance).

Anyway, I'll stop before taking this discussion too far off course.
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Re: "The Worst ETFs You Can Own"

Postby Swelfie » Tue Jul 18, 2017 2:17 pm

Tamalak wrote:"It is weasel-worded, but the clear message is: do not use leveraged ETFs as part of any buy-and-hold strategy."

Are we absolutely sure about this?

If we tracked a 2x total stock ETF over 100 years, would that still be worse than a 1x total stock? I'm guessing yes.

But what about a 1.1x? A 1.5?

I don't remember where but I believe I read that, depending on what period you're looking at, the highest historical return is at 1.5x or so leverage.

Obviously, the risk is much higher, and most likely the Sharpe ratio is worse. I'm not doing it personally. But I'm tempted.


It's not at all about the leverage. Levered ETFs don't just lever and hold the asset, so they don't behave at all like a levered portfolio except during the course of a single day (they adjust when the market closes). So if you buy a 2xTSM ETF then you are NOT doing the same thing as 2x gearing in your stocks.

In fact, what they do is equivalent to getting margin called every day the market is down by the slightest amount, and then buying high at every opportunity. Probably not what you want.

A few posts above I shared some info on how you can undo their adjustments by trading in the opposite direction and make them behave more like a true levered investment, but it takes active monitoring to do so.

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Re: "The Worst ETFs You Can Own"

Postby nisiprius » Tue Jul 18, 2017 2:45 pm

Tamalak wrote:"It is weasel-worded, but the clear message is: do not use leveraged ETFs as part of any buy-and-hold strategy."

Are we absolutely sure about this?

If we tracked a 2x total stock ETF over 100 years, would that still be worse than a 1x total stock? I'm guessing yes.

But what about a 1.1x? A 1.5?

I don't remember where but I believe I read that, depending on what period you're looking at, the highest historical return is at 1.5x or so leverage.

Obviously, the risk is much higher, and most likely the Sharpe ratio is worse. I'm not doing it personally. But I'm tempted.
No, you're mistaken. You don't get it. This isn't a "how much leverage" issue, this is a "leveraged ETFs don't do what you think they do" issue.

You're thinking of the "Kelly criterion" stuff, and you're badly mistaken because you still don't "get" the difference between a 2X total stock ETF and buying stocks with 2X leverage. That's the big, big problem, and it's what keeps trapping people. It's a completely separate problem from the question of whether a sane person should be 60/40, 90/10, 100% stocks, or mildly leveraged.

The "1.5X" you read about was probably 1.4X, and it refers to true leverage, i.e. you borrow the money to the buy the stock--you have $100,000 to invest, you borrow $40,000, and buy $140,000 worth of stock. I always need to refresh my memory on exactly what the Kelly criterion optimizes or maximizes, it's not "return." Over any particular period of time in which stocks earned a positive return, the highest return is always obtained by using the most leverage, without limit!

The problem is that a 2X leveraged ETF is not the same as a 2X leveraged investment. One appealing thing about the ETF is that it doesn't have anywhere near the same risk as a 2X leveraged investment because you can't lose more than you invest in it. Well, that isn't a free lunch.

Let's say you decide that you want a 1.5X leveraged investment. If leveraged funds and ETFs did what you think they do, you could achieve that simply with a 50/50 split between a straight S&P 500 fund, like VFINX, and a 2X leveraged S&P 500 fund, like ProFunds UltraBull (ULPIX).

Portfolio 1, blue: plain old 100% VFINX.
Portfolio 2, red, true 1.5X: 150% VFINX, -50% cash.
Portfolio 3, yellow, 1.5X leveraging DAILY-ONLY leveraging achived by using 50% VFINX, 50% ULPIX.

Source

Image

Using true leverage would have given you more return, and you would have taken more risk to get it--including the risk of going below zero, owing money, and perhaps getting a margin call.

Using the 2X ETF would have given you about the same amount of risk as true leverage, but you not only wouldn't gave get the same return, you actually did worse than an unleveraged investment even though the stock market went way up over that time period.
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